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A closer look at the Nikkei and Yen correlation - BBH

FXStreet (Guatemala) - Analysts at Brown Brothers Harriman broke down the correlation in the Nikkei and Yen and explained the relationship in detail and relative to a means of hedging and the profiting methodology in the crossover.

Key Quotes:

"The two track each other, and sometimes, like now, very tightly".

On a day-to-day basis, it may not always be clear which is leading, but the co-movement is nearly intuitive. A bullish dollar yen view is also a bullish Nikkei view and vice versa.

“It is also important for investors to consider the correlation of the returns of the two instruments”.

“Among other things, this is critical for hedging decisions and other money management issues. And here the correlation is considerably lower, but still not insignificant”.

“The correlation of the percentage change of the dollar-yen exchange rate and the percentage change in the Nikkei is around 32.5%, on a 60-day rolling basis. In August it peaked above 48%. In June 2013 it was above 58%”.
“The correlation of returns is also not particularly stable”.

“Consider this 60-day rolling correlation had been inverse for a few weeks this past July. In addition, the correlation might not be causal. The combination of the BOJ's Halloween surprise, the same day the Fed formally ended QE3+, and the pension fund diversification helped spur both the Nikkei and the dollar-yen. This has been followed by two important things. First, there does not seem to be much of an official push back against the yen's relatively sharp drop. We think there is a reasonable chance of this as the JPY120 area is approached. Second, the decision to postpone the sales tax may have also favored shares and the dollar over the yen”.

“Nevertheless, some analysts insist on projecting the target of one - say dollar-yen - to the price of the other. For example, if one expects the dollar to rise another 10% against the yen to say JPY130, then some analysts will translate that to say a 13% move in the Nikkei or roughly 19500. What this means is that dollar-based investors will give up the bulk of their possible gains in a basket of Japanese stocks through the potential exchange rate developments. There are various ways institutional investors can hedge the currency risk”.

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